August 24th 2011: Preview - Big impact on risk conditions from German IFO release
Following contrasting fortunes in Tuesday’s German releases, the trio will be completed by the German IFO index on Wednesday. The data will be extremely important for Euro sentiment as it will give vital insights into the probable German economic trajectory and wider Euro-zone pressures over the next few months. The initial impact may be seen more in risk appetite as a very weak figure would increase fear substantially, especially as banking fears would intensify.
Markets have already priced in a significant deterioration and the Euro should be resilient if there is only a measured decline from July levels and a figure above 110 which is certainly the more likely outcome should not cause lasting Euro damage. In contrast, a sharp decline would certainly increase fears surrounding the German and wider Euro-zone economy and increase underlying vulnerability, especially as political cohesion would come under serious stress. In particular, any figure below 107 would be a big setback for the Euro and put pressure on the Australian and Canadian dollars with the US currency rallying hard.
The German expansion has been the key locomotive behind the Euro-zone economy over the past two years and, needless to say, any downturn would have an important negative impact on growth prospects, both for Germany and the peripheral economies. Fears over the banking sector would also increase further if the cushion of solid growth is removed.
There will also be an important impact on political sentiment within Germany. While the economy was growing strongly, the internal political barriers to increased Euro-zone support measures were easier to bear. As the economy starts to weaken, political tolerances and the willingness to provide further assistance will also tend to deteriorate as domestic fears take priority. The potential obstacles for Chancellor Merkel to overcome would also be substantially higher as fears over domestic employment would increase. In a weak growth environment, the potential burden of support would also be higher and there would be a potentially bigger impact on Germany’s budget and credit rating.
The IFO index has been extremely resilient over the last few months and surprisingly only reached a peak at 114.5 in the June reading before slipping back. This is a substantially different picture than that recorded by the ZEW survey which has dropped further and for longer.
To give some context, the survey reached a low point just above 82 in the first quarter of 2009 before advancing steadily for over two years. There is little immediate prospect of these kind of numbers being repeated, but the general tone of the release will be important in indicating how severe any downturn will be.
Follow breaking developments on Twitter - @Investicafx
For a full list of market previews follow this link Market Previews